Practical analysis for investment professionals
16 January 2015

The Swiss Franc: Markets 1, Central Banks 0

In this world of central bank guarantees, bank bailouts, central bank manipulation of interest rates, trillion-dollar quantitative easing (QE) campaigns, and capital controls, one could be forgiven for believing that central banks are more powerful than markets. This is a fallacy. They aren’t.

So this week, when the Swiss National Bank (SNB) broke the Swiss franc’s cap (of 1.20) to the euro, it demonstrated that the SNB had conceded central bank power to market power. Why do I say that? Wasn’t it just the SNB’s response to market conditions? No. The move was inevitable. It was simply a matter of time.

To understand this, we must first acknowledge and accept that there is but one global, albeit disjointed, monetary system. Monetary policies by one central bank — especially large ones like the European Central Bank (ECB) — can and do impact monetary policies in other countries, especially smaller ones like Switzerland. Back in 2009–2010, when the European sovereign debt crisis first reared its ugly head, it created a massive amount of capital flight out of the eurozone. So, many investors, banks, corporations, etc., chose to put their money in Switzerland, seeing the Swiss franc (CHF) as a safe haven, which in turn drove up the value of the Swiss franc. As illustrated in the following graph, the franc appreciated from approximately 1.6 francs per euro before the crisis to about 1.05 francs per euro between October of 2008 and August of 2011 (green shaded area).


Sources: European Central Bank, Quandl, CFA Institute.

To stem the capital inflows into Switzerland, the SNB placed a cap on the CHF-EUR exchange rate at 1.20 francs per euro in September of 2011. In effect, the SNB then linked their monetary policy to the ECB. Mechanically speaking, the cap meant that the SNB had to print francs and purchase foreign currencies to offset the market forces.

However, in September 2014, the ECB cut rates and also announced a new program to purchase bonds — further easing monetary policy. Due to the SNB’s cap on the exchange rate, the ECB’s announcement meant that the Swiss bank faced a choice: either accelerate the printing of francs to offset the incremental monetary stimulus from the ECB, or exit the cap and return to market exchange rates. After nearly three years, the Swiss are raising the white flag. Market forces win.

There are two primary ramifications from these events. First, a powerful meme that central banks are all-powerful compared to markets has once again been shattered. Just because central banks can tweak market prices at their discretion does not mean that central banks can permanently control markets. And the tipping point creates massive dislocations as central banks shift from manipulated exchange rates to market exchange rates (and vice versa).

Moreover, these sudden, large shifts in policy are not captured well in statistical analysis. The relatively mundane day-to-day variations in prices during “normal” times tend to overwhelm the few large regime shifts in quoted prices.

The immediate effect is that anyone (e.g., Swiss companies) who has costs or liabilities in francs and revenues or assets in euros or other currencies is at risk. Few were prepared for such a dramatic shift in currencies. The 30% move in the franc will no doubt hobble the financial profile of many Swiss companies. The higher franc lowers the cost of imports into Switzerland and, for the moment, reduces the inflationary pressures on consumer products brought about by the massive money printing of the SNB. However, the influx of capital bids up prices of local assets in Switzerland, like real estate and bonds, which are extraordinarily expensive already.

These actions also impair trust between the markets and governments. Just days earlier, Thomas Jordan, the president of the SNB, affirmed the bank’s commitment to the cap. Only three days later, he said, “We came to conclusion that it’s not a sustainable policy.” You don’t say?

In the final analysis, the SNB actions ultimately demonstrate the difference between currency and money. The SNB can of course control currency in circulation and regulate the banking system (which affects the money supply), but the value of that currency is determined by people. You and me. How we buy that currency, how we sell that currency, and how we spend that currency. And we just told the world’s central bankers that the appropriate value of the franc is a lot more than 1.20 euro. And it isn’t because we like the franc that much. How could we? It’s because we dislike the euro even more. There wasn’t any other way. Central banks 0. Markets 1.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo credit: © Bryukhanova

About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, was Director of Economics & Alternative Assets at CFA Institute, where he wrote about economics, monetary policy, currencies, global macro, behavioral finance, fixed income and alternative investments, such as gold and bitcoin (among other things). Previously, he served as SVP and Director of Large-cap Equity Products for BB&T Asset Management, where he led a team of research analysts, 300 regional portfolio managers, client service specialists, and marketing staff. He also served as a Senior Vice President and Lead Portfolio Manager of large-cap equity products at Mesirow Financial. Rimkus earned a BA degree in economics from Brown University and his MBA from the Anderson School of Management at UCLA. Topical Expertise: Alternative Investments · Economics

7 thoughts on “The Swiss Franc: Markets 1, Central Banks 0”

  1. asdasd says:

    fully agree

    1. Asdad, thanks for your comments!

  2. abhay says:

    Yes i agree.. But if this to be considered then the yuan which is pegged at a fix rate against dollar must had surrender to market forces way back.
    I wonder how chinese central bank keep buying dollars from last so many years and has managed the exchange rate.!

    1. Abhay, thanks for your comments as well. The issue with China is different in so far as the economy has grown at a fast pace, the special relationship China (as producer) has with America (as consumer), the size and scope of China, and the growth and magnitude of debt. What has transpired in China is consistent with my points on the SNB. China simply has much more wherewithal to extend and distort market signals. Thx again!

  3. karthik says:

    I personally feel the crux of the issue is not about who is winning it but how would one sustain some santity in the fundamentals of the already beleaguered euro region.

    I think this unpegging of Swiss francs against the euro pretty much signifies that the SNB has thrown in the towel. QE by the ECB, abysmally low crude have all contributed to the Swiss central bank resigning to its fate.

    I, for one would never support pegging currencies by central banks but if there was any time where a central bank had to continue pursuing intervention in currency markets, it was this.

    It could have persuaded the Swiss govt to impose quantitative restrictions or the ‘quota raj’ as we call it india to arrest the inflows. This, coupled with the negative interest rates prevailing in Switzerland could have had the desired effect in the economy, even if it means going back to the pre-liberalised era, if need be.

    But by reverting to the market driven exchange rates at this juncture, they are only going to invite more inflows despite the negative rates as the gains to be had on currency appreciation would offset the losses incurred in negative interest rates.

  4. karthik says:

    Disappointed to see my comment not featuring here. It might be radical view that’s against the popular opinion. ..But it’s my personal view point. Could i even know what was wrong with what i said??

    I Would be grateful if the moderator points out at it with a mail to above said address

  5. Bruce says:

    Thanks for the note. You raise some good points, but I think your premise is off. It’s not Central Banks vs. the markets, rather the Central Banks ARE the markets (Japan CB buying essentially every new government bond issue being the most obvious example).
    As you point out, the Swiss CB had the option of continuing to print francs to intervene to buy Euros and choose not to. But choice is the key word there. They were not forced to. The economic consequences of selling so many Francs to buy Euros is potentially more inflation which, at the moment anyway, is nowhere in sight. So the Swiss CBs decision was political not economical. I’m not saying it was a bad decision (putting the cap on in the first place was the bad decision), but I am saying the markets didn’t force the Swiss CB into it.

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